FIFO
Costing Overview
In addition to Standard and
Weighted Average Costing methods, there is an additional primary cost method
known as FIFO. This method of costing is generally accepted and widely used. FIFO
is acronym for “First In, First Out”. As the name suggest, in FIFO, the
earliest received stock is used first while the latest received stock is still
on hand. The FIFO costing follows the principle that materials used should
carry the actual experienced cost of the specific units used. This functionality
is available in Oracle EBS since 11.5.2. The blog emphasizes on FIFO Costing
Overview and Cost Accounting Challenges for implementation of the same.
FIFO Costing is a method of
identifying inventory based on the assumption that costs should be charged
against revenue in the order in which they occur. The inventory remaining on
hand is presumed to consist of the most recent costs. FIFO approximates the
results that would be obtained by the specific identification method of costing
inventory. This means that the cost is determined by the association of flows
of the inventory.
The
Oracle Way
Oracle EBS provides FIFO/LIFO as
one of the costing method. FIFO is also known as Layer Costing in Oracle. It is
because items are received and grouped together sharing same cost. FIFO layers
are maintained at Item/Org/Cost Group level.
Available inventories are made
of identifiable cost layers. They are of two types.
Inventory
Layer
On-hand inventory contains
layers that are receipt-based (purchased items and return items) or completion-based
(manufactured items). Miscellaneous transactions also create their own cost
layer.
Work
In Process (WIP) layer
Components issued to a WIP job
are maintained in layers within the job itself. Each issue to WIP represents a
separate layer within the job. In addition, each WIP layer consists of only one
inventory layer initially consumed by the issue transaction. The costs of those
inventory layers are held separately within the WIP layer.
Features
of FIFO Costing in Oracle EBS
FIFO
costing is organization specific. All Items in the organization will be valued
at FIFO when you specify FIFO as primary costing method. It works similar to
average costing in regards to cost sharing. Cost sharing is not possible in
case of FIFO costing organizations. When user receive a quantity against a
purchase order and deliver it to inventory; one layer will be created for the
received quantity. The cost of items in the layer is nothing but purchase order
line price for the item. Layer creation does not take place for specific
item-organization combination for same transaction type, cost and cost group.
The quantity will be added to last layer in such cases. When quantity is issued
from the inventory; the oldest layer with quantity balance are consumed first
and costed based on cost of consumed layer. In case of WIP jobs, component
issued to the jobs are held as different layer within the jobs. The rerun
transactions such as WIP component return, RMA receipt and return to vendors
creates new layer in inventory but they are costed differently. WIP component
return transactions are costed at WIP layer cost and RMA receipt and return to
vendor transactions are costed at original cost (shipment and receipt in this
case). User can update layer cost or cost of elements of layers. The cost
update process calculates the adjustment values for your inventory layer cost,
and creates corresponding adjustment accounting entries. Oracle provides
ability to report by layer cost.
Challenges
for FIFO
- Business transactions have to be processed in sequence. Any out of sequence transaction can potentially create incorrect accounting. Normally this is insured by keeping inventory transactions mode as On-Line.
- FIFO works only for receipts in and issues from inventory; other transactions such as material transfers and project transfers do not follow FIFO and may lead to accounting issues.
- FIFO Costing is not consistent with inventory control such as Lot and Serial Numbers. Costs for a particular lot or serial are not maintained in FIFO costing. Users won’t be able to track cost by lot or serial number using FIFO. This is currently true with other costing methods too.
- FIFO costing works only within a single inventory org and it may not be possible for companies to use FIFO across multiple orgs.
- Similarly, if multiple locations are mapped in a single inventory org, users will not be able to use location (subinventory) specific FIFO.
- Updating FIFO costs for multiple layers of inventory is more difficult and time consuming compared to standard or average costing.
- FIFO costing methods leaves some unanswered questions. FIFO costing results in inflated COGS and deflated margins. In case of manufacturing companies, cycle time for product can be high since the material moves through different manufacturing stages. For special customer orders, sometimes emergency purchases are made which results in inflated COGS and deflated margins but not necessarily in the same period. It becomes difficult to answer why margins are so low or COGS are high in such cases.
- The size and cost of units are large.
- Materials are easily identified as belonging to a particular purchased lot.
- Not more than two or three different receipts of the materials are on a materials card at one time
- FIFO costing eliminates purchase price variance and job close variance.
- There is no need to rollup and update standard costs for items and product structures.
- Companies can close inventory periods faster.
- FIFO method provides is applicable for more business scenarios and also provides better accounting
- Materials used are drawn from the cost record in a logical and systematic manner
- Movement of materials in a continuous, orderly, single file manner represents a condition necessary to and consistent with efficient materials control, particularly for materials subject to deterioration, decay and quality are style changes
- The FIFO method is supported by the IFRS framework which is followed in Most of the countries.
- Oracle cost Management User Guide, Release 12.1
- FIFO/LIFO Perpetual Costing Overview, Laura Miller, September 2001
- http://www.accounting4management.com/fifo_method_of_materials_costing.htm
- http://www.archerpoint.com/blog/Posts/which-dynamics-nav-costing-method-should-manufacturers-choose
